What does the future hold for public company auditing in the United States, and what are the implications for professionals, regulators, and educators? While the authors are strong proponents of the auditing profession and its contribution to society, they see several emerging areas of concern: 1) the relatively slow growth of the public company auditing market, 2) the increasingly rigorous PCAOB inspections, 3) the profession’s relatively low starting pay and intense working conditions, and 4) the far-reaching impact of emerging technology. Overall, the public company auditing profession is facing some serious challenges, but the authors believe that steps can be taken now to bolster the long-term prospects of the profession.
Public company auditing provides critical protection to investors and ultimately contributes to the efficient allocation of economic resources. Financial markets rely on high-quality information, and the auditing profession plays a key role in ensuring information quality. Nevertheless, the authors, and others, have observed several recent developments in the auditing profession, including the relatively slow growth of the public company auditing market, heavy PCAOB regulation, low starting pay and intense working conditions, and the impact of emerging technology (see the Exhibit). Each of these factors gives us pause as we consider where public company auditing is headed. We are strong proponents of the auditing profession, having worked in the field with great people, learned a tremendous amount in our public company auditing years, and prepared many students for entry into the auditing profession. The purpose of this article is to highlight these concerns, discuss their implications, and speculate how best to prepare the auditing profession for the future.
Slow Growth in Public Company Auditing
The authors see the public company auditing market today as a relatively slow-growth sector, especially in comparison to the advisory service line. For example, according to the Wall Street Journal, “Since 2012, consulting and advisory revenue has grown 63%, compared with 11% for audit revenue” (Michael Rapoport, “Big Four Accounting Firms’ Revenue Rises 10.4%, Strongest Growth in Years,” Dec. 14, 2018, https://on.wsj.com/2sQROdT). The growth rate for consulting and advisory is thus nearly six times that of auditing over this period. The article also reported that auditing accounts for only about one-third of Big Four revenues, and that Big Four audit revenues have been outpaced by consulting and advisory revenues since 2015. Thus, the Big Four arguably are not audit firms that also do consulting; rather, they are consulting firms that also do auditing. This represents an apparent return to pre-Enron levels of consulting, when auditing was only one-third of Big Five revenues (Stephen Barr, “Breaking Up the Big 5,” CFO Magazine, May 1, 2000, http://bit.ly/2GjWdJE).
One apparent contributor to the relatively slow growth of auditing revenues is the rapidly declining number of U.S. public companies, which total less than half of the number in the late 1990s (Bloomberg, “Where Have All the Public Companies Gone?” Apr. 9, 2018, https://bloom.bg/37nBsZ9). This decline is often attributed to two factors: heavy, costly regulation of public companies since the major accounting scandals of the early 2000s, and alternate sources of capital for growing companies, such as private equity (Gary Halbert, “Number of U.S. Public Companies Falls by Almost 50%,” Value Walk, July 31, 2018, http://bit.ly/2RkBvzj).
The impact of the declining number of U.S. public companies is partially offset by the recent rise of audit fees for larger public companies (i.e., accelerated filers). Specifically, Audit Analytics reports that audit fees per million dollars of client revenue increased from $450 in 2012 to $548 in 2017, a 22% rise (Sixteen-Year Review of Audit Fee and Non-Audit Fee Trends, December 2018, http://bit.ly/3ax3YK5). Audit fees per million peaked in 2004 at $573, due to the implementation of the Sarbanes-Oxley Act of 2002 (SOX).
Since the implementation of SOX, audits of internal control over financial reporting also have served to bolster the audit market. More and more public companies, however, are exempted from this requirement, and a new SEC proposal would exempt smaller reporting companies from internal control audits (Matthew Heller, “SEC Approves Audit Exemption for Smaller Firms,” CFO.com, May 9, 2019, http://bit.ly/37mouLp). Thus, the public company internal control audit market may be shrinking.
Overall, a top-level market analysis reveals a relatively slow-growth auditing market, an audit service line that has been surpassed by consulting and advisory within the Big Four, and a pool of public companies that is less than half of what it used to be, as well as expanding exemptions from internal control audits. This is not a picture of a dynamic, rapidly growing sector, but rather a relatively stable annuity of audit revenues that reflects a shrinking component of overall revenues.
Rigorous PCAOB Inspections
The PCAOB oversees the audits of public companies. A key focus of the PCAOB is its inspections of audit firms; these inspections, especially of large firms, clearly are very rigorous, and the PCAOB often finds many audit deficiencies. See, for example, recent PCAOB guidance (“Staff Preview of 2018 Inspection Observations,” 2019, http://bit.ly/2TQlFOJ) for a discussion of recurring problem areas, including internal control over financial reporting, risk assessment and revenue, accounting estimates, and engagement quality review. In addition, an analysis by Susan Hermanson, Rebecca Sawyer, and Jenny Parlier found that large audit firms have many of the same problem areas repeatedly flagged by the PCAOB (“Insights for Internal Auditors from Recent PCAOB Inspection Reports,” Internal Auditing, July/August 2019).
Recent research also indicates that public company auditors do not view PCAOB oversight positively. For example, Dana Hermanson, Richard Houston, Chad Stefaniak, and Anne Wilkins interviewed auditors in large firms and found that partners viewed regulation as the leading negative element of an auditing career (“The Work Environment in Large Audit Firms: Current Perceptions and Possible Improvements,” Current Issues in Auditing, Fall 2016, http://bit.ly/3aBYjlV). Likewise, Lindsay Johnson, Marsha Keune, and Jennifer Winchel interviewed auditors about the PCAOB inspection process and found low trust in the PCAOB and an “antagonistic environment” (“U.S. Auditors’ Perceptions of the PCAOB Inspection Process: A Behavioral Examination,” Contemporary Accounting Research, October 2018, http://bit.ly/37l6HEd). These two studies suggest that PCAOB oversight, despite the benefits that it might provide, has not enhanced the attractiveness of an auditing career.
Providing direct insight into this conclusion, Kim Westermann, Jeffrey Cohen, and Greg Trompeter surveyed and interviewed auditors and concluded, “The inspection process has created excessive stress and tension, beyond budget and fee pressures, which some auditors perceive as affecting the pool of talented auditors that firms may be able to attract and retain in the future” (“PCAOB Inspections: Public Accounting Firms on ‘Trial,’” Contemporary Accounting Research, August 2018, http://bit.ly/38zVRul). Thus, there is evidence that PCAOB oversight may affect the willingness of some individuals to enter or remain in public company auditing.
The extreme pressure of the PCAOB inspection process may be negatively incentivizing the behavior of individual auditors to the point of illegality. In the case of auditors at KPMG, according to the SEC:
Senior personnel sought and obtained confidential PCAOB lists of inspection targets because the firm had experienced a high rate of audit deficiency findings in prior inspections and improvement had become a priority. Armed with the PCAOB data, the now-former KPMG personnel oversaw a program to review and revise certain audit work papers after the audit reports had been issued to reduce the likelihood of deficiencies being found during inspections” (“KPMG Paying $50 Million Penalty for Illicit Use of PCAOB Data and Cheating on Training Exams,” press release, June 17, 2019, http://bit.ly/2NR2pgo).
Ultimately, KPMG agreed to a $50 million settlement with the SEC. There also were criminal proceedings against certain individuals.
Overall, the current era is one of rigorous PCAOB oversight of the auditing profession. Research indicates that auditors do not view PCAOB inspections positively, and issues with PCAOB oversight may lead to talented people leaving the auditing profession. One Big Four firm, in the case of KPMG, apparently sought to undermine the integrity of the PCAOB inspection program, and the authors are aware of PCAOB inspection experiences causing individuals to exit the public company auditing profession.
Low Starting Pay and Intense Working Conditions
A Korn Ferry study indicates that the average starting pay for a U.S. college graduate, across all majors, is just over $51,000 per year (Kelsey Gee, “Class of 2019 Gets a Smaller Pay Raise,” Wall Street Journal, May 15, 2019, https://on.wsj.com/3aFskB8). Furthermore, 2019 starting pay for college graduates was 20% higher than in 2009.
In accounting, however, starting pay in the Big Four firms’ audit practices is relatively low and appears to have stagnated in recent years. Specifically, Joseph Carcello indicates that typical Big Four audit starting pay (outside of major markets like New York) was approximately $50,000 in 2007 (“Human Capital Challenges Facing the Public Company Auditing Profession,” Current Issues in Auditing, June 2008, http://bit.ly/38ys9G3). Today, across several online salary surveys (see “Big 4 Accounting Firms,” Management Consulted, http://bit.ly/2TQfni4; and “Complete Big 4 Salary Guide,” Big 4 Career Lab, http://bit.ly/37m6lxn), Big Four audit starting pay typically is in the mid $50,000s. (Many smaller firms now appear to pay more than the Big Four.) Big Four audit starting pay appears to have moved very little in the last 12 years, and it is now just ahead of the average pay for college graduates in general. This level of starting pay does not appear consistent with what one would expect for CPA-pursuing graduates from professional schools, who typically must have 150 hours of education—an extra year of educational costs and foregone salary. Furthermore, there is almost no premium paid to those holding a master’s degree versus those having 150 undergraduate hours. The Big Four do not pay overtime, and annual bonuses likely do not come close to covering all of the overtime worked, based on an 8% median bonus (Big 4 Career Lab). Thus, beginning Big Four auditors actually may fare worse than the average college graduate on a starting hourly pay basis, especially when also considering the extra year of educational costs and resulting delay.
Starting pay in the Big Four firms’ audit practices is relatively low and appears to have stagnated in recent years.
Why do the Big Four pay so little for entry-level audit talent? As many have observed, “Because they can.” The Big Four can offer low starting pay because there is a career-long benefit to having a Big Four firm on one’s résumé. The contacts, training, and experience that the Big Four offer serve as a form of deferred compensation. Interview evidence reveals that staff auditors often view themselves as underpaid for the hours worked. Furthermore, low starting pay can create a strong sense among entrants that they will only stay with the firm for a short time (Hermanson et al. 2016). The authors recognize that Big Four audit partner pay is much more generous, with one source describing the average as $650,000 to $850,000 (“Big 4 Partner Compensation—How High Is It, Really?” Big4Bound.com, http://bit.ly/2sNNEU2), and much higher for more experienced partners—but very few individuals stay to reach the partner level.
Adding to the low starting pay is the continuing intensity of the working conditions in public company auditing. Hermanson et al. (2016) found average busy season workloads of 72 hours per week for audit staff in large firms. A survey of primarily Big Four auditors found average busy season workloads of 65 hours per week, with the average maximum of 80 hours per week (“Auditor Perceptions of Audit Workloads, Audit Quality, and Job Satisfaction,” Julie Persellin, Jaime Schmidt, Scott Vandervelde, and Michael Wilkins, Accounting Horizons, December 2019, http://bit.ly/3aECCBO). Furthermore, they examined auditors’ job satisfaction, concluding, “Auditors’ job satisfaction and their excitement about auditing as a career are negatively impacted by high audit workload, particularly when the workload exceeds a threshold that is perceived to impair audit quality.” In addition, they found that participants’ career excitement declines markedly from the first day of their career to the present. Hermanson et al. (2016) found similar results, as none of the staff interviewed planned to remain in public accounting for the long term. These findings also parallel earlier research documenting unmet expectations (“A Longitudinal Study of New Staff Auditors’ Initial Expectations, Experiences, and Subsequent Job Perceptions,” Heather Hermanson, Mary Hill, and Susan Hermanson, Advances in Accounting Behavioral Research, January 2009, http://bit.ly/2ROmd4W).
An apparently related issue is that younger workers appear to have a strong desire for work-life balance. For example, a 2013 survey (PwC’s NextGen: A Global Generational Study, 2013, https://pwc.to/3ayPOYZ) concluded, “Millennials value work-life balance, and the majority of them are unwilling to commit to making their work lives an exclusive priority, even with the promise of substantial compensation later on.” Such a view seems to run counter to the traditional public accounting work environment and deferred compensation model.
Overall, public company auditing has long been an intense profession, with long hours and deferred gratification. What appears to have shifted somewhat in recent years is that the starting compensation relative to other disciplines has declined (Carcello 2008), and younger workers seem especially focused on work-life balance. With the Big Four’s pyramid structure, low staff pay, and long hours, it appears that the basic nature of public company auditing remains a brief stop in an accounting or business career.
As large audit firms move toward greater usage of continuous auditing software, technology-enhanced 100% testing of populations, and ultimately artificial intelligence (PCAOB, Inspections Outlook for 2019, 2018, http://bit.ly/3aGPYxw), the authors foresee two key human resources issues. First, the large firms’ human resources model for decades has involved hiring a lot of inexpensive college graduates, working them very hard for a couple of years, and then having most of them leave, to be replaced by new waves of inexpensive labor. This pyramid structure depends on most people leaving the firm—and they do leave, as public accounting firms have relatively high annual turnover rates (“The State of the Profession,” The CPA Journal, December 2018, http://bit.ly/2MiAyHz). If, however, enhanced use of technology decreases the need to hire large numbers of staff auditors, firms may find themselves in more of a stovepipe structure (outsourcing of routine audit tasks also contributes to this issue). A key challenge in a stovepipe structure is retaining enough staff and seniors to fill the ranks at the manager level and higher. What changes in the compensation or working environment do the firms plan to implement in order to dramatically increase staff and senior retention in such a structure? Are the firms ready to shift to a human resources model that is focused on most people staying instead of most people leaving?
What appears to have shifted somewhat in recent years is that the starting compensation relative to other disciplines has declined, and younger workers seem especially focused on work-life balance.
Second, new auditors traditionally have performed a great deal of detailed audit work, learning about accounting systems, internal controls, misstatements, and business processes. As auditing moves toward greater use of technology and big data (and outsourcing of routine tasks), an emerging challenge may be how to structure firm training so that auditors who have not been through the detailed audit work themselves can effectively move to higher-level oversight roles. In a sense, this is analogous to the challenge of teaching the details of the accounting process in a world where software handles much of the bookkeeping.
To summarize the discussion above, the public company auditing profession appears to be characterized by relatively slow growth, heavy PCAOB regulation, low starting pay, long hours, low career satisfaction, and impending technology impacts. The authors offer the following questions for consideration by the SEC, PCAOB, large audit firms, and educators:
- Will the differential growth rates of advisory and audit services ultimately lead to advisory practices seeking to split off from the Big Four firms so as to avoid subsidizing the audit practices? While such an audit-only Big Four firm structure arguably could enhance auditor independence, provide a singular focus on the audit, and promote professionalism, there also could be some significant questions raised by an audit-only focus. Would investors lose protection due to audit-only firms’ smaller size and more limited financial resources? Would the Big Four’s business models be threatened in an audit-only world? Would audit-only firms have the same level of in-house information technology and business expertise that the Big Four have today? Would audit-only firms be able to attract the same caliber of new hires, and would the desired skill set change? Finally, would audit-only firms be able to provide the same level of internal training and development for employees?
- Have regulatory costs facing public companies gone too far, such that economic growth and access to public markets are being dampened in favor of intense oversight of public companies? More specifically, should regulators focus on increasing the number of U.S. public companies? If compliance and regulatory costs are the big issue, what steps can be taken to alter the cost/benefit calculus in favor of going public?
- How can PCAOB oversight be improved in a way that enhances audit quality without lessening the appeal of working as an auditor? The research evidence has consistently shown auditor dissatisfaction with inspections, as well as documented some perverse auditor behaviors in response to inspections. In fact, Westermann et al. (2019) note, “Some respondents believe that being a good auditor has come at the expense of being a good accountant; the emphasis on audit process and concurrent de-emphasis on technical accounting could ultimately lead to audits themselves falling short.” The authors strongly encourage the PCAOB’s new leadership to work even more collaboratively with audit firms to improve inspections and to focus as strongly as possible on whether the audit conducted was substantively sound and less so on whether the auditors documented each audit step exactly as the inspector would have done. As Hermanson et al. (2016) note, “The PCAOB must walk a very fine line in regulating the profession … Ultimately, audit quality will surely suffer if too many good people choose to leave the profession.”
- Is public company auditing destined to remain a short-term, “churn and burn” stop in the career of many accountants? The traditional pyramid structure, low starting pay, and long hours seem designed to quickly move large numbers of inexpensive laborers through the audit firm system and into industry. To the extent that technology moves the large firms toward more of a stovepipe structure, it appears that these firms will need to make major changes in their compensation and staffing models, such as higher starting pay and more reasonable hours. This would reflect a profound shift in the large firms’ culture and human resources policies. Are the large firms discussing this prospect? What plans are being made to attract and, more importantly, retain the next generation of auditors? Furthermore, how will auditor training evolve to ensure that more senior auditors grasp the nuances of detailed audit work when technology has handled much of the details?
- How does the development and deployment of new auditing technologies affect audit firms’ efforts to maintain independence as they provide a broader scope of technology-enhanced services to clients for the purpose of enhancing the reliability of financial reporting? For example, what independence and other issues are raised by the external auditor and management jointly employing continuous auditing and monitoring solutions? Could audit firms’ efforts to deploy technology-based solutions that would enhance financial reporting quality be constrained by such concerns?
- What do educators tell their students about public company auditing careers? The authors have observed many instances in recent years where top students indicated zero interest in the Big Four because of the stories they had heard from others. Are firm recruiters always forthcoming about the realities of long hours and high stress? How do educators ensure that students know what they are getting into without unduly scaring them away from public company auditing?
The traditional pyramid structure, low starting pay, and long hours seem designed to quickly move large numbers of inexpensive laborers through the audit firm system and into industry.
A Profession Worth Fighting For
Public company auditing is not an easy profession, but it can offer career-long benefits, such as the authors have enjoyed. Ultimately, investors need high-quality, reliable financial information for investment decisions, and the authors hope that the integrity of this information can be attested to by audit professionals who enjoy long-term, satisfying, dynamic careers.